Co-working, malls pose threat to office market
The largest office supply pipeline in more than 20 years, the rise of co-working and the changing configuration of our shopping centres pose a risk to the high-performing office markets of Sydney and Melbourne, a recent analyst note from the National Australia Bank warns.
According to NAB analyst Andrew Jones, risks on the supply side of the office market are rising given a “substantial” pipeline, with forecasts suggesting 2020 will bring the largest net addition of floorspace for Sydney and Melbourne since the 1990s.
“Office absorption is closely linked to the state of the economy, heightening the downside risks to effective rents and vacancy rates,” Mr Jones said.
“The recent experience of the Sydney and Melbourne office markets has seen business absorb vacant and new space. However, this positive absorption cycle has only been in place since 2014 or so and prior to that there was a relatively shallow period of negative net absorption,” he added.
Office absorption in the Sydney and Melbourne CBD was negative in the first half of 2019.
Not only will landlords be confronted with new supply in the market, but also added factors specific to this cycle – namely the growing phenomenon of co-working spaces and the changing nature of our shopping centres, which could spell trouble for office landlords, the note said.
“The rise of WeWork … and other ‘workspace solutions’ providers has been a phenomenon of the current cycle, consistent with broader economic and structural trends.”
“However, we note that the ability of counterparties to service leases is only as strong as the sub-leasees. Co-working flexibility may accelerate negative net absorption in a downturn.”
Risks for landlords
Industry experts have recently warned about the risks landlords face as co-working operators shift a gear and pursue large swaths of space in individual buildings.
If economic conditions weaken and co-working operators can’t find tenants to fill the space landlords could be left highly exposed, particularly given many companies use special-purpose vehicles to enter leases allowing them to potentially walk away if they cannot pay the rent.
In the United States last week Boston Federal Reserve Bank president Eric Rosengren similarly warned of a “new type of potential financial stability risk” co-working spaces could have on commercial real estate and the broader US economy.
The NAB note warned that the changing tenancy composition of shopping centres also added to a challenging office market.
“While previously highly unlikely, the rationalisation plans of large retail anchor tenants (Myer, David Jones, BigW, Target, etc.) have created more office space.
“The conversion of more anchor retail space into office cannot be downplayed given a co-working hub is set to replace Myer’s lease at Emporium in May 2020 and with WOTSO’s entry last year into Scentre’s Westfield Chermside, which is a non-CBD shopping centre in Brisbane.”
Sydney and Melbourne’s office markets are both performing strongly given the underinvestment in the sector, as well as stock withdrawals for large infrastructure projects and apartment conversions during the residential boom.
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